Cryptocurrencies are digital currencies that operate on peer-to-peer networks and, in most cases, independently of centralized authority (i.e., governments and banks). The first cryptocurrency was the bitcoin, which was released in 2009. Since then, numerous other types of cryptocurrencies have entered the market, each with its own technical differences, but generally operating in a similar way.
Bitcoins are stored in a holder’s digital wallet and can be transferred from one person to another. However, all transactions are transparent and recorded in the bitcoin blockchain (a decentralized public ledger), which can be viewed online by anyone and traced using a wallet address.
While bitcoins are created through so-called mining performed by computers that solve complex algorithms, they can also be purchased and sold in return for traditional currency, traded anonymously, or used to purchase goods or services.
Although the Canada Revenue Agency (CRA) has described digital currency to be “virtual money,” it has to date stated that “virtual currencies, such as bitcoins, are not considered to be currency issued by a government of a country.” Instead, the CRA treats such currency to be a commodity for the purposes of the Income Tax Act, and using currency such as bitcoins to purchase goods or services would be treated as a form of barter transaction. The result is that every time a bitcoin is sold or exchanged for another property (such as another cryptocurrency), the exchange would trigger a disposition for tax purposes and a corresponding gain or loss in Canadian dollars.
The tax treatment of a taxpayer buying and selling bitcoins using traditional currency will be either on account of capital or on account of income. If the bitcoin is considered to be capital in nature, only 50% of the gain realized from its sale is taxable as a taxable capital gain. If the bitcoin is viewed to be inventory of a business, any gain realized on a disposition is fully taxable as business income.
New cryptocurrencies may be obtained by initial coin offerings (ICOs) or forks (when the blockchain of the existing cryptocurrency is split or duplicated to create a new cryptocurrency with its own blockchain, e.g., the Bitcoin Cash fork). In the case of an ICO, generally investors acquiring and selling new cryptocurrencies would follow the tax treatment discussed above; however, there are cases when the tax treatment may be more complex. While the CRA has issued some guidance on digital currencies, such as bitcoin, by labelling them a commodity, it has not issued any guidance as to the treatment of fork events for tax purposes. The act and case law are also silent on this, as these types of transactions are still very new.
Bitcoin and cryptocurrencies are still relatively new, in that the determination of their legal and regulatory status is still ongoing. As such, there is still a great deal of uncertainty surrounding the taxation of cryptocurrencies.
For more information, contact Blake Allan, senior manager, MNP International Tax Services, at 778-372-5323 or [email protected].
